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Equities performed very weakly in December, resulting in a year which posted a loss overall. Our expert, Johan Gallopyn, takes stock of the previous month and the year 2018 in terms of the equity, bond, currency and commodity markets.

Equity markets

The month of December 2018 will go down in history. Indeed, the S&P 500 index posted its worst monthly return (-9,2% in USD) in nearly one decade. December’s decline gained momentum after the US Federal Reserve raised interest rates, and suggested that two additional rate hikes were to be expected in 2019. Markets had hoped the Fed would pursue a more dovish policy, because there are concerns that an overly aggressive monetary stance would sharply hamper the economy and halt corporate profit growth, in the context of an economy that is already sending out signals of slower growth. The US government shutdown also weighed on market sentiment, although there is no immediate economic impact. A conflict between president Trump and Congress on the financing of the border wall with Mexico forms the basis of the issue. Just like the rest of 2018, December was characterized by volatility: in the last month the S&P 500 also saw the largest one-day gain (+5%) in the past ten years. In December, emerging markets fared relatively less badly, thanks to the weaker USD and the slightly improving sentiment on the trade conflict between the United States and China. Asian emerging markets in particular underperformed throughout 2018 because of the economic slowdown in China.

Bond markets

In December, US interest rates continued the descent they had started back in November. 10-year bond rates closed the year at 2.75% versus a 3.25% peak in November, which is still higher than the 2.40% that was reached at the beginning of the year. The dismal performance of equity markets in the past month has lured investors to safe government bonds. The market was also supported by the expected growth slowdown in the US in the course of 2019 and the predicted reduction in the pace of the central bank’s interest rate hikes. German 10-year interest rates ended the year lower than they had started it, as opposed to their US counterparts. Hence, this is one of the most striking trends of the year. Slower-than-expected growth in the eurozone and political uncertainties are the main explanations. However, one of these uncertainties dissipated in the course of December, when the Italian government reached an agreement with the EU to curtail the 2019 budget deficit to 2.04% of GDP, as opposed to the 2.4% that had been suggested earlier. This will prevent the EU from launching the excessive deficit procedure. Markets reacted positively to the deal, and Italian bond rates fell dramatically. Corporate bond spreads rose significantly in the course of the past month, thus continuing their trend of the previous months. High yield corporate bonds in particular saw spread levels rise in a general context of risk aversion, and due to expectations that slower economic growth will deteriorate the quality of this market segment.

Central banks and monetary policy

For the first time in seven years, the Swedish central bank hiked its policy interest rate with 25 basis points to -0.25%. The hike came despite disappointing inflation readings which were announced earlier. In any case, the central bank confirmed its prudent outlook and does not expect a next rate hike before the second half of 2019. The European Central Bank’s bond purchase program will be discontinued as of the month of January, as planned. From now on, only bonds that reach maturity will be reinvested. The ECB expects to continue these reinvestments for a considerable time after the first rate hike. As widely anticipated, the US Fed raised its short-term interest rates for the fourth time this year. The Federal Reserve adapted its outlook for additional rate hikes in 2019 and beyond to the downside. For the coming year, the Fed now assumes there will be two rate hikes (one in each half of the year) as opposed to three rate hikes.

Currencies

In December, the euro appreciated versus most currencies. Only safe-haven currencies like the Swiss franc and the Japanese yen were able to gain ground. The Swedish krona rose following the rate hike. The USD however depreciated versus the euro, while this currency is often considered a safe haven in turbulent markets, and despite the Fed raising interest rates in the past month. The weakness of this currency is probably the result of the correction in the equity markets, which also hit US markets this time. The British pound fell after the optimistic sentiment we saw in November, but remained within the range the currency has been trading in against the euro for more than one year. Following the delayed vote in British parliament on the Brexit agreement, which was planned for December 11, there is still a great deal of uncertainty over the timing and conditions of the Brexit.

Commodities

Oil prices fell very sharply again in December. Since the over 85 USD/barrel highpoint reached in early October, prices have fallen by 35%. On December 7, OPEC and Russia reached an agreement to decrease production by 1.2 million barrels per day. This cut will come into effect in January, but markets are still not convinced that this will be sufficient to restore the market equilibrium. Indeed, supplies remain abundant and shale oil production is at record levels. Moreover, the embargo against Iran has been partly offset by exemptions of a number of countries. This should be seen against the backdrop of uncertain demand resulting from overall softer economic growth. Gold recovered strongly in December because of the sell-off on equity markets, which lured investors to the safe-haven status of the precious metal. Gold ended the month at the highest level of the past six months, and ends the year with a slight loss. Industrial metals crept lower in December, ending a volatile year that was dominated by fears over the economic slowdown in China in the second half of the year.

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